Perfect Competition
CH 9
Hans Martinez
Western University
Perfect Competition (Review)
- What is Perfect Competition?
- Profit Maximization by a Price-Taking Firm
- Short-Run vs. Long-Run Equilibrium
- Economic Rent and Producer Surplus
- Profit Maximization Implies Cost Minimization
Perfectly Competitive Markets
A perfectly competitive market consists of firms that produce identical products that sell at the same price
Each firm’s volume of output is so small in comparison to the overall market demand that no single firm has an impact on the market price
Perfectly Competitive Markets - Conditions
- The industry is fragmented
- It consists of many buyers and sellers
- Firms produce undifferentiated products
- Consumers perceive the products to be identical no matter who produces them
- Consumers have perfect information about prices
- The industry is characterized by equal access to resources
- All firms —incumbents and prospective entrants— have access to the same technology and inputs
Implications of Conditions
The first characteristic implies that sellers and buyers act as price takers
The second and third characteristics imply a law of one price
The fourth characteristic implies that the industry is characterized by free entry
The Profit Maximization Hypothesis
\[
\begin{align}
\max_{Q} \pi(Q)&=R(Q)-C(Q) \\
\text{s.t. } Q&\ge0
\end{align}
\qquad(1)\]
Economic Profit = Sales Revenue - Economic (Opportunity) Cost
firm sells output Q; R(Q), revenue from selling the quantity; C(Q) = economic cost of producing the quantity Q
The Profit Maximization Condition Continued